Competitive pressure builds on architects and their insurers

Barnette: As an insurance broker, my responsibility in preparing for this panel was to interview others in the sales end of the business to determine what they see as the major issues in procuring insurance coverage for design professionals. I also spoke with underwriters.

Probably the most consistent statement I heard was that there is abundant capacity for most design firms. There are 20-plus markets that offer architects and engineers professional liability insurance. One West Coast broker pointed out that the market could be influenced by hurricanes Katrina, Rita and Wilma. Property underwriters who suffered large losses are going to be looking for a new source of cash. They may view the architects and engineers market as being profitable and decide to get into it–with inexperienced underwriters and lower rates. Once they start to see losses, however, they'll exit the market as fast as they entered. So the forecast was for a lot of new players over the next 12 to 18 months, then an exodus and a return to higher rates.

Almost every agent I spoke with also mentioned that insurers are niche underwriting in an effort to improve results. They're looking for design professionals that identify a specialty and stick to it. They're avoiding exposures that have not been profitable, one of the main ones being project policies.

Another trend is that specialty agents, who used to book 90% to 100% of their coverages with one market, have had to reassess where they place business. The demise of some of those markets, followed by successor markets' re-underwriting, has left them feeling vulnerable. They want to spread their business, so they're not subject to the whims of one company. Insurers' niche underwriting also often compels them to cultivate relationships with additional carriers or wholesale brokers.

There is extremely broad coverage available in the marketplace. That's always been the case in the standard market, but the E&S market has expanded coverage as well. For example, E&S carriers have agreed to provide coverage for mold on a case-by-case basis. One underwriter told me that he was not at all reluctant to do so, because his company's claims experience had not been severely affected by mold claims. First-dollar defense occasionally is available. There's pressure on underwriters to lower deductibles for renewals. Coverage for punitive damages is readily available. The definition of professional services can be amended to include coverage for personal injury. The "who is an insured" definition on some surplus-lines policies can be modified to include joint ventures or other equity interests.

For harder-to-place risks, surplus-lines underwriters tell me rates will probably be flat. But for premier accounts, there could be continuing decreases of 5% to 10%, especially for companies with $5 million or less in annual fees, which is almost becoming a commodity class of business in the standard market.

Some exposures continue to be difficult to place, despite the entrance of new capacity in the market. These include structural, geotechnical and environmental engineers, as well as architects and engineers with design- build operations. Professional liability markets really want to exclude coverage for construction exposures. General liability coverage for architects and engineers also has been affected. Traditionally, many design firms secured their general liability coverage as part of a BOP policy. That's nearly impossible to do now for design professionals with significant construction exposures.

Probably the most difficult exposure for producers continues to be projects, stemming from the unfavorable experience underwriters and reinsurers have had with project policies. There have been blockbuster losses, stemming from such things as retractable roofs on stadiums, which have taken a lot of time to get right. There also has been claim frequency. Even small projects seem to be notorious for cost overruns, delays and change orders, all of which can lead to claims.

Design professional firms are being underwritten based on the percentage of their total fees developed from condominium work. Some very large design professional firms apparently are limiting or walking away from condo work. So the smaller firms that are picking up this work have a disproportionately large percentage of their fees coming for condo work. As a result, their premiums are unaffordable–assuming they can even get coverage.

One of the most interesting comments I heard was from an agent who said she was having difficulty placing her "weird" people, meaning those small operations started by professionals who leave large firms to go out on their own and find a way to make more money. They may gravitate toward less-desirable risks in regard to the business they pursue, making it a challenge to find affordable coverage for them, if it is available at all.

Henderson: The main point I would like to make is that financial pressures on design professional firms are creating real problems. Whereas in the past, negligence tended to drive claims, now accelerating financial pressures are.

In regard to these pressures, those of us in the industry often view project owners as the bad guys, who are making our insureds sign contracts with egregious terms. But they are under a lot of financial pressures themselves. They are in hyper-competitive industries, and their project costs are going through the roof. To make a profit, they must act as they do. One thing they do is squeeze the supply chain–including architects and engineers.

Among other things, this leads to irrational underbidding. We continue to see design fees decrease as a percentage of construction values. That's a serious concern, because rates are based on those fees. Traditionally, design fees have equaled 3% to 5% of construction values. Now they're drifting under 1%. As a result, insureds are taking on more exposure for less money.

The very way in which design professionals do business adds to the pressure on them. Most of us get a paycheck every two weeks. That's not the case if you own an A&E firm. To get work–and income–design professionals have to be the successful bidders on projects–in an extremely competitive business.

As a result, some firms bend their standards. Maybe a year ago they wouldn't work with certain contractors they knew were bad news. Today they might relent. Often, the project owners are calling the shots, so the design professionals pretty much do as they're told. They agree to really overbearing contract terms. Maybe they take on types of projects with which they've had little experience. They may go to distant locales, where they are unfamiliar with the market and local contractors. You also see a tendency to cut corners. They may be tempted to use cheaper materials or take on a questionable subcontractor. There are dozens of other ways that financial pressures come into play.

Therefore, from an underwriting standpoint, we like to see larger design-professional firms that have adequate resources. We want people who have staying power, who won't have to file for bankruptcy if they are unsuccessful on three consecutive bids. It's also critical for architects and engineers to have strong internal management procedures, particularly proactive risk management.

The market for architects and engineers professional liability insurance also is being affected by trends in design-build and construction management. There's increasing acceptance of both methods. Design-build and construction management firms started out in private-sector projects. Recently, they've made inroads into the public sector projects, too, although public entities in some states are barred from using them.

(Editor's note: Under traditional building methods, a project owner contracts separately with a design firm and a contractor, each of which is responsible for its work. Under the design-build process, a project owner contracts for all services needed to create the project from one source. Usually, this is a large contractor that either employs design professionals or subcontracts for their services. Architects and engineers sometimes engage in the process themselves, in which case they typically contract out the construction work. Under the construction-management approach a contractor may function as a project owner's consultant, overseeing the work of the design professionals and contractors with whom the project owner has separately contracted.)

Antwine: I'd like to talk about some exposures these arrangements create. You have almost an adversarial relationship between construction managers and design professionals. The construction managers have control of the project and in some cases may usurp the authority of the architect. They can put pressure on the design professional to change a design component, which could lead to a loss. We're talking about potentially grave consequences: building collapse, work-site death and long-term injuries. These claims tend to be for full policy limits and may burn through several layers of excess insurance as well.

Fast-track construction is another issue of concern. This is the practice of starting a project before the designs have been completed. Nothing good comes of this. Fixed price, or guaranteed maximum price contracts, also are a problem. I call them "guaranteed cost" contracts–for the design professional. Offering a guaranteed price is music to the owner's ears, but it doesn't eliminate cost overruns. Construction managers and design-build firms have two overriding concerns: time and money. They want to deliver a project on time and within budget. That doesn't always add up to a quality project–and the architect or engineer could be left holding the bag if something goes wrong.

Henderson: Construction defect litigation is another issue affecting architects and engineers. Rapid growth, like that you see in a lot of Sunbelt states, seems to lead to construction-defects claims. When you get rapid growth, the goal is to build a project quicker and cheaper, and to get it open as soon as possible, so it can start generating revenue for paying off construction loans. When those loans become due, they are payable every month in huge amounts–whether the project has been finished on time or not. So there's tremendous pressure to get these projects done as fast as possible and on time. Nobody–not the project owner, the lender or the surety-bond company–wants to hear excuses; they just want to get the work done. Too often, this leads to shoddy practices and subsequent litigation. The problem is most severe in certain high-growth states, like California, Arizona, Colorado, the Carolinas, Florida and, to an extent, Texas.

From an underwriting perspective, we have to look carefully at design professionals who are involved in this kind of work and who are situated in such states. If a firm has experienced construction defects claims, we need to know exactly how they were drawn in and what risk-management steps they've taken to reduce the odds of such claims in the future. I don't want to give the impression that such firms are uninsurable. There are architects and engineers that do high quality work and that follow some sort of "best-practices" standards. That's the best defense they, and we, can have.